Sec Enforcement Techniques: Expanding And Exotic Forms Of Ancillary Relief

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Volume 32 Issue 3 Article 4
Summer 6-1-1975
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AAnncciillllaarryy RReelliieeff
James C. Treadway, Jr.
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James C. Treadway, Jr., Sec Enforcement Techniques: Expanding And Exotic Forms Of Ancillary
Relief, 32 Wash. & Lee L. Rev. 637 (1975).
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SEC ENFORCEMENT TECHNIQUES: EXPANDING
AND EXOTIC FORMS OF ANCILLARY RELIEF
JAMEs C. TREADWAY, JR.*
The enforcement process of the Securities and Exchange Commis-
sion has a widespread impact upon the corporate and financial world.
It is generally recognized that the Commission has extensive regula-
tory powers over certain members of the financial community, such
as broker-dealers, securities exchanges and registered investment
companies. However, through its enforcement procedures, the SEC
has begun to exert increasing control over ordinary commercial and
industrial companies, accounting firms, and even law firms. This new
and expanded control over such entities is not confined to transac-
tions universally accepted as subject to the jurisdiction of the SEC,
such as raising funds by selling stock to the public. The immediate
past has seen the Commission use enforcement cases as a means of
exacting substantial concessions from alleged violators of the federal
securities laws, often resulting in direct SEC involvement in the in-
ternal affairs of the alleged violator.
In recent enforcement cases, the SEC has obtained the appoint-
ments of a receiver displacing incumbent management' and of special
receivers or masters to make public disclosure and reports of corpo-
rate transactions and affairs.2 The Commission has also obtained
substantial changes in the make-up of a board of directors which
effectively deprived the alleged violators of their dominant control of
the corporation3 and similar restructurings of executive committees.4
Other SEC involvement in internal corporate affairs includes "bar-
gaining" for concessions pursuant to which management agrees to
retain special counsel to advise it with respect to its obligations under
*Member of the firm of Dickstein, Shapiro & Morin, Washington, D.C. A.B.
(1964), University of Georgia; L.L.B. (1967), Washington & Lee University.
'E.g., SEC v. U.S. Tank Car Corp., SEC Litigation Release Nos. 6512 (Sept. 11,
1974), 6520 (Sept. 17, 1974) and 6573 (Nov. 4, 1974), SEC v. Arata, SEC Litigation
Release No. 6180 (Dec. 27, 1973). The SEC attempted but failed to obtain similar relief
in SEC v. Brigadoon Scotch Distrib., Ltd., CCH FED. SEC. L. REP. 94,980 (S.D.N.Y.
Feb. 11, 1975), and SEC v. Clinton Oil Co., Civil Action No. W-5020 (D. Kan. Jan.
15, 1973).
'SEC v. Koenig, 469 F.2d 198 (2d Cir. 1972).
'SEC v. Mattel, Inc., SEC Litigation Release Nos. 6531 (Oct. 2, 1974) and 6467
(Aug. 8, 1974).
'SEC v. Mattel, Inc., SEC Litigation Release No. 6531 (Oct. 2, 1974); SEC v.
Great Coastal Gas Corp., SEC Litigation Release No. 6054 (Sept. 12, 1973).
638 WASHINGTON AND LEE LAW REVIEW [Vol. XXXII
the federal securities laws,5 and the institution of internal corporate
procedures and controls to prevent future violations of the securities
laws.'
Industrial corporations and their managements have not been the
only ones to fall subject to such unusual sanctions in the context of
enforcement cases. Under pressure from the SEC, a major accounting
firm has agreed to submit to a review of its internal procedures by
fellow accountants,7 another accounting firm has agreed to send one
of its partners to a refresher course,8 and a law firm has agreed to
adopt certain internal controls and to embark upon a continuing
education program for certain of its members.'
All of these developments have occurred in the context of enforce-
ment cases brought by the SEC under the Securities Act of 193311 and
the Securities Exchange Act of 1934,11 both of which are denominated
as disclosure laws by their preambles. In addition, these acts are
quite specific in granting the SEC its general powers to take action
against violators, primarily the power to seek injunctions against
violations. Section 20(b) of the 1933 Act12 and § 21(e) of the 1934 Act 3
contain virtually identical language, which provides in pertinent
part:
Whenever it shall appear to the Commission that any person
is engaged or about to engage in any acts or practices which
constitute or will constitute a violation of the provisions of this
title, or of any rule or regulation. . . , it may in its discretion,
bring an action . . . to enjoin such acts or practices .... 11-1
'SEC v. Great Coastal Gas Corp., SEC Litigation Release No. 6054 (Sept. 12,
1973).
6SEC v. Canadian Javelin, Ltd., Securities Exchange Act Release No. 11172 (Jan.
9, 1975); SEC v. Allegheny Beverage Corp., SEC Litigation Release No. 6670 (Jan. 8,
1975); SEC v. Mattel, Inc., SEC Litigation Release Nos. 6531 (Oct. 2, 1974) and 6467
(Aug. 8, 1974); SEC v. Sunshine Mining Co., SEC Litigation Release No. 6544 (Oct.
11, 1974).
7In re Laventhol, Krekstein, Horwath & Horwath, Securities Exchange Act Re-
lease No. 10172 (May 23, 1973). See also In re Touche Ross & Co., Securities Act
Release No. 5459 (Feb. 25, 1974).
sIn re Benjamin Botwinick & Co., Adm. Proc. File No. 3-3518 (Jan. 15, 1975).
'In re Jo M. Ferguson, Securities Act Release No. 5523 (Aug. 21, 1974). See also
SEC v. Spectrum, Ltd., 489 F.2d 535 (2d Cir. 1973). Cf. SEC v. National Student
Marketing Corp., 360 F. Supp. 284 (D.D.C. 1973).
1r15 U.S.C. § 77a, et. seq. (1970).
"15 U.S.C. § 78a, et. seq. (1970).
1215U .S.C. § 77t(b) (1970).
"315 U.S.C. § 78u(e) (1970).
"-'Emphasis added.
1975] SEC ENFORCEMENT TECHNIQUES
Despite this seemingly uncomplicated and straightforward lan-
guage, in enforcement cases the SEC has increasingly obtained the
forms of relief enumerated above, in addition to the statutory injunc-
tion against future violations. Such exotic relief is generally referred
to as ancillary relief, and there is ample precedent for ancillary relief
in injunctive proceedings, dating back to some of the earliest cases
decided under these acts.4 When decreed by a federal court, such
relief has been granted on the theory that the court has broad discre-
tion in fashioning remedies for securities law violations since it sits
as a traditional court of equity.
This article does not purport to examine the general equity power
of the federal courts; rather, it focuses upon recent enforcement cases
which involve exotic and novel forms of ancillary relief with poten-
tially far-reaching consequences for generally unregulated entities. In
so doing, some conclusions are drawn as to the basis upon which the
SEC determines that it will seek ancillary relief, whether the forms
of ancillary relief in the cases are consistent with the disclosure phi-
losophy of the 1933 and 1934 Acts, and whether as a policy matter
the SEC should be so involved in the internal affairs of corporations,
accounting firms, and law firms.
It is important to remember that virtually all of the enforcement
cases discussed herein were settled by mutual consent, generally
without any admission or denial of violations,15 and were not litigated
on the merits. As a result, the decrees emanating from them are
"E.g., Deckert v. Independence Shares Corp., 311 U.S. 282 (1940); Kardon v.
National Gypsum Co., 73 F. Supp. 798 (E.D. Pa. 1947).
15As a procedural matter, the method of settling cases in this fashion involves the
execution of a "Stipulation and Consent to Final Judgment of Permanent Injunction"
by the SEC and the defendant. This is then presented to the court, which enters the
agreed-upon injunction based upon the Stipulation and Consent. The language which
is critical in making it clear that there is no finding of a violation of law generally reads
as follows:
This Stipulation and Consent is entered into solely for the purpose of
settlement of this action, without trial or argument of any issue of fact
or law. Neither this Stipulation and Consent, nor the entry of judg-
ment herein in accordance with the Final Judgment of Permanent
Injunction in the form annexed hereto, shall constitute any evidence
or any admission or any adjudication with respect to any allegation
of the Commission's complaint or any fact or conclusion of law with
respect to any matter alleged in or arising out of the Commission's
complaint, or of any wrong-doing or misconduct on the part of defen-
dant XYZ or any of its officers, agents, servants, employees, succes-
sors, assigns, or any person or persons acting in concert or participa-
tion with it.
640 WASHINGTON AND LEE LAW REVIEW [Vol. XXXII
without broad judicial approval. Nevertheless, it is important to at-
tempt to assess the potential consequences of the trend represented
by these decrees.
It must be emphasized, however, that the discussion of these cases
is in no way intended as any conclusion or implication that violations
of the law in fact occurred or that any defendant or person associated
with any defendant was engaged in any illegal, improper, or unethical
activity.
I. Limited Receiver for Disclosure Purposes
One of the more important recent cases dealing with ancillary
relief in SEC enforcement cases, in part because it is one of the few
cases litigated and decided on the merits, is SEC v. Koenig.8" In
Koenig, the SEC commenced two enforcement actions against a
publicly-held corporation and its president within a relatively short
period of time. Both actions were based principally upon alleged
violations of § 10(b)"7 of the 1934 Act and Rule 10b-5,18 generally
arising out of allegedly misleading or inaccurate press releases and
failures to make public disclosure of the true state of various corpo-
rate affairs and transactions.
In the first case, the SEC sought the standard injunction against
future violations of the securities laws. This case was settled by con-
sent without any admission of violation by the defendants. In the
second case, however, the SEC also sought the appointment of a
"limited receiver" with the power to investigate the affairs of the
corporation and to make timely and accurate reports of the state of
its affairs to the SEC, to its stockholders and to the general public.
Despite the defendants' contentions to the contrary, the Second Cir-
cuit ruled that courts could appoint such limited receivers and that
such relief was appropriate in light of the nature of the alleged courses
of conduct of the defendants.
In so ruling, the Second Circuit affirmed the district court9 which
had ruled in favor of the limited receiver sought by the SEC. The
district court had given cogent and explicit reasons for its decision.
The court emphasized that the defendants had engaged in a "com-
plex set of secret securities transactions"'" which had the effect of
leaving the court in the position of being unable to determine the
6469 F.2d 198 (2d Cir. 1972).
715 U.S.C. § 78j(b) (1970).
117 C.F.R. § 240.1ob-5 (1974).
1[1972-1973 Transfer Binder] CCH FED. SEC. L. REP. 93,536 (S.D.N.Y. 1972).
'Id. at 92,561.
1975] SEC ENFORCEMENT TECHNIQUES
nature and extent of the injury to stockholders. The court therefore
considered the limited receiver "necessary to preserve the status quo
while an accurate picture of what transpired is obtained."'" It then
proceeded to enumerate the sins of the defendants: "misleading and
late reports to the SEC," "incomplete press reports to the public,"
the secret transfer of "voting control of valuable European subsidiar-
ies" to the individual defendants, and the frustration of "all attempts
of dissident shareholders to change the present management. '2 Hav-
ing made these findings, the court formulated the following decree
and ancillary relief:
In view of these past activities, the Court concludes that it
cannot rely on the defendants to implement the directions of
the Court. ... A receiver therefore will be appointed and will
be directed to (1) investigate the recapitalization of the Euro-
pean subsidiaries of ECO; (2) make full, complete and accur-
ate public disclosure of all material events and facts concern-
ing the defendants, their officers, agent, servants, employees,
directors, subsidiaries and affiliates; (3) make timely and ac-
curate filing of reports with the SEC in conformity with Sec-
tion 13(a) of the Securities Exchange Act and the Rules pro-
mulgated thereunder and to make those amended filings nec-
essary to correct those reports presently filed; (4) issue a report
to ECO stockholders for the years 1970 and 1971; (5) hold a
1972 annual ECO stockholders' meeting and (6) make ECO's
books and records and stockholder list available to any ECO
stockholder who is legally entitled to access to these docu-
ments.2
The receiver appointed by the court was former New York Mayor
Robert Wagner, who conducted his investigation and prepared his
report much in the capacity of an "independent legal auditor."
Thereafter, he distributed a thirty-five page report which detailed
various transactions which the SEC had alleged to involve violations
of the securities laws. The report concluded that certain explanations
of officers and directors as to why the transactions occurred were
"illogical and therefore incredible,2'4 and drew conclusions as to
whether certain actions taken by incumbent management were for
21Id.
22M.j
"Id. (footnotes omitted).
2Report submitted by Robert F. Wagner, Receiver, Pursuant to Order of United
States District Court, Southern District Of New York, 1973, p. 5.
642 WASHINGTON AND LEE LAW REVIEW [Vol. XXXII
the benefit of stockholders or whether, to the contrary, they lacked
any legitimate corporate purpose. The report was highly critical of
management, concluded that management had released false finan-
cial information to the public,and generally took a dim view of vir-
tually all the corporate actions attacked by the SEC in its complaint.
As previously noted, part of the significance of this case is that it
is one of the few cases involving such extraordinary relief which was
litigated rather than settled by consent. Another important aspect is
that the ancillary relief was limited to the concept of disclosure, the
basic philosophy of the 1933 and 1934 Acts. The court specifically
referred to the receiver as a "limited receiver," and his powers were
confined to conducting an investigation and making public disclosure
of the results of his investigation.
In light of the egregious nature of the violations alleged and found
by the court, this case should be considered for comparison purposes
when evaluating subsequent enforcement actions brought by the SEC
in which the relief sought is much broader, even though the alleged
violations appear no more extreme. Such a comparison prompts one
to speculate whether the Koenig2 decision was the beginning of a now
pronounced trend, as a range of later enforcement actions seem to
indicate. Of course, one can only speculate as to the thought pro-
cesses of the SEC, but subsequent cases seem to indicate that this
may be so.
II. The OutrightR eceiver- A Bargaining Tool and an End In Itself
In some instances the SEC apparently has concluded that the
type or extent of alleged violations of the securities laws are such that
ancillary relief which goes well beyond disclosure is warranted. A
significant example of such a case is SEC v. Clinton Oil Co.,2 which
1
a former SEC Commissioner has cited as an example of "more com-
prehensive and effective relief' in the enforcement area.27
Clinton Oil was one of the glamour companies of the 1960's and
the early 1970's, attracting widespread investor interest. The com-
pany was engaged in oil and gas exploration, principally financed by
the public sale of limited partnership interests in oil and gas drilling
funds.2 The common stock of the company was also publicly traded.
23a69 F.2d 198 (2d Cir. 1972).
"'Civil Action No. W-5020 (D. Kan. Jan. 15, 1973).
'Speech of Former SEC Commissioner Hugh Owens before the North American
Securities Administrators, September 1973.
2The interests in these limited partnerships were the subject of registration state-
ments filed under the Securities Act of 1933.
1975] SEC ENFORCEMENT TECHNIQUES
Clinton Oil reached its zenith when it sold its 1969 drilling program
to the public for $100,000,000, the largest oil and gas program ever
sold. Yet, according to the SEC's complaint, all was not well with
Clinton Oil, and had not been well for many years. Among other
things, contrary to Clinton's announcement, the spectacular 1969
program was not fully sold to the public. Instead, approximately
$30,000,000 of the sales were on credit, meaning that Clinton Oil had
received no cash for these sales. Furthermore, for a substantial period
of time Clinton and its insiders had received interests in various
drilling programs on credit, subsequently exchanging those interests
for stock in the company, and finally selling the stock to pay the
indebtedness. In addition, sales of Clinton common stock by insiders,
were carefully orchestrated to avoid depressing the market price of
the common stock, and the company was also making loans to insi-
ders to buy Clinton stock in the open-market to bolster the price of
the stock. None of this was disclosed to the SEC or to public inves-
tors.
To remedy this situation, the SEC's complaint included a prayer
for:
An order appointing a receiver to take control of all of the
business of defendant Clinton Oil Company and authorizing,
empowering and directing such receiver to take charge thereof
to conduct the same until order of the court; and to require
said receiver to obtain an accounting of all disbursements by
Clinton Oil Company to each defendant named herein for the
period January 26, 1966, to the effective date of said receiver-
ship."
While the goal of the SEC in this case may have been admirable -
and certainly the alleged fraud was massive and blatant - it should
be noted that the relief requested went well beyond the concept of
disclosure. Indeed, one of the SEC's other prayers was for an order
that Clinton Oil amend all previously filed reports with the SEC to
correct alleged disclosure deficiencies." Thus, supplementing the re-
lief relating to disclosure, the additional relief sought by the SEC
would have had the effect of ousting incumbent management and
transferring total control over the company to a court-appointed re-
ceiver.
Although the receiver the SEC sought was not appointed, Clinton
2SEC Complaint at 45, SEC v. Clinton Oil Co., Civil Action No. W-5020 (D. Kan.
Jan. 15, 1973).
"Id. at 43.
644 WASHINGTON AND LEE LAW REVIEW [Vol. XXXII
Oil was settled by a consent decree which indirectly involved the
same result. The defendants consented to a court-supervised change
in management in which the principal perpetrators of the alleged
scheme were removed and new, independent management was
brought in to try to maintain Clinton Oil as a viable corporation.
Consequently, even though the SEC did not obtain the appoint-
ment of a receiver, the mere existence of the prayer for appointment
proved a powerful bargaining tool. The only way incumbent manage-
ment could have avoided the appointment of a receiver and remained
in control of the company was by a long trial which in all probability
would have involved at least one appeal. The expense would have
been enormous, the pressure incalculable, and the exposure in com-
panion private civil actions staggering if the case had been lost. Ac-
cordingly, the defendants apparently concluded that discretion was
the better part of valor and yielded to a settlement which involved
no admission of violation.
The progression from Koenig to Clinton Oil is worth remember-
ing. In Koenig, which was decided approximately 18 months before
Clinton Oil, the SEC's prayers for relief were tied strictly to disclo-
sure. In Clinton Oil, the relief originally sought covered the whole
gamut of disclosure and also sought to effect a change in manage-
ment. Thus, within a relatively short period of time, the SEC prog-
ressed to the point of evaluating the fitness of a corporation's man-
agement and, upon concluding that it was unfit to run a public com-
pany, seeking its ouster. The progeny of Koenig and Clinton Oil serve
to demonstrate how rapidly this trend has accelerated.
SEC v. U.S. Tank Car Corp.3 is a recent case which illustrates
this trend. The defendants in U.S. Tank Car allegedly sold various
unregistered securities in the form of interests in railroad tank cars
and an accompanying management program for the cars. According
to the SEC's complaint, in excess of $9 million in proceeds which were
received from various investors from August 31, 1973, until June 30,
1974, were not used to purchase tank cars. Of this amount, only
$878,300 was paid to tank car manufacturers. The defendants alleg-
edly diverted the balance of the proceeds to their personal use, while
providing fraudulent certificates of ownership to investors. The SEC
sought the standard preliminary and permanent injunctions, as well
as appointment of a receiver. After a hearing, the Court entered a
temporary restraining order and appointed an attorney as a receiver
31SEC Litigation Release Nos. 6512 (Sept. 11, 1974), 6520 (Sept. 17, 1974), and
6573 (Nov. 4, 1974).
1975] SEC ENFORCEMENT TECHNIQUES
of the corporation.2
In assessing the apparent reasons for the prayer for a receiver in
light of Koenig and Clinton Oil, it should be noted that U.S. Tank
Car involved alleged fraud in the form of outright theft of investors'
funds. In light of such blatant violations, the SEC obviously felt that
the traditional injunction or remedies confined to disclosure were
insufficient under the circumstances. Apparently, in this case the
SEC viewed diversion or theft of investors' funds as grounds for seek-
ing extraordinary forms of relief, including a receiver. From a purely
visceral level of justice and equity, it is easy to applaud the SEC's
efforts in a case such as U.S. Tank Car. If the SEC's allegations in
such cases turn out to be true, massive and blatant violations of the
securities laws will have occurred and defendants will have demon-
strated a patent unwillingness to comply with the law. In U.S. Tank
Car, it appears that the egregious nature of the violations, coupled
with the element of diversion of investors' funds, prompted the SEC
to seek the extraordinary relief involved.
SEC v. Brigadoon Scotch Ltd. 3 is an example of another case
wherein diversion or potential diversion of investors' funds was in-
volved and the SEC sought broad ancillary relief, including the ap-
pointment of a receiver. The SEC alleged that the various Brigadoon
defendants were offering for public sale without compliance with the
registration requirements of the 1933 Act certain unregistered securi-
ties, namely investment contracts in the form of interests in scotch
whiskey and in rare coin portfolios.34 The SEC also alleged various
violations of the anti-fraud provisions of the securities laws.35 In addi-
tion to the usual injunctive relief, the SEC sought the disgorgement
by all defendants of all proceeds received in connection with their
sales of unregistered securities and the appointment of a receiver of
the assets and property of the defendants to, among other things,
assist investors in obtaining the return of their investments and to
distribute to investors the proceeds disgorged by the defendants. The
SEC also sought an order freezing the assets of the defendants pend-
ing the disposition of its request for this ancillary relief, as well as an
order staying and restraining all creditors of the defendants.
On February 11, 1975, a hearing was held before the court on the
SEC's motion for a preliminary injunction.35 The court first ruled that
"SEC Litigation Release No. 6520 (Sept. 17, 1974).
"SEC Litigation Release No. 6640 (Dec. 12, 1974).
'Securities Act of 1933 § 5, 15 U.S.C. § 77e (1970).
"Securities Act of 1933 § 17(e), 15 U.S.C. § 77q(a) (1970); Securities Exchange
Act of 1934 § 10(b), 15 U.S.C. 78j(b) (1970).
"SEC v. Brigadoon Scotch Distrib., Inc., CCH FED. SEC. L. REP. 94,980